Global Perspectives: Finding balance in a shifting market landscape

We are recording this mid-October right after a blowout U.S. job prints that nobody saw, and prior to the next inflation data point. Markets continue to hold on to every data print, and there will be volatility. But from a high-level perspective, equities continue to touch their market highs, and fixed income credit continues to outperform. As investors sit with money markets at record levels on the sidelines wondering where to go next, it can be difficult to understand the best opportunities going forward. So, to address this, I’m thrilled to be joined by the two co-portfolio managers of the Janus Henderson Balanced Strategy, Greg Wilensky and Jeremiah Buckley. And today we’re going to talk about, from a high-level perspective, the landscape of equities, fixed income, and multi-asset. Gentlemen, thank you for being here today.

Greg, let’s go to you first. You’re the Head of U.S. Fixed Income at Janus Henderson. How do you view the broad economy and the path of the Fed going forward?

Greg Wilensky: So, to think about the rate cycle, I think we have to put into perspective our view on the economy. Our base case right now is for a soft landing, we expect economic growth to continue to be moderate, for the labor market to come into better balance, and it has been coming into better balance than it was last year, and for inflation to continue to trend toward the Fed’s 2% target. That’s our base case. There’s clearly risks around that, and views on which way those risks can skew have certainly changed, as you said, data point by data point.

Our view as far as the Fed is concerned, they started with that 50 basis-point rate cut in September. Our view will be, given our soft-landing scenario, that we will see 25 basis-point cuts in both November and December. I would have said that was our view before the September print. I would have said at that point, or before that number came out, that if we were wrong, that it would skew towards a 50 basis-point cut at one of those meetings. Now I think the distribution around that base case view is a little more symmetric. I think the market is looking, or as you said hanging, on each print a little too much. We were actually thinking that the market was getting a little bit ahead of itself on pricing in too many cuts prior to the employment number that came out and saw a massive move post-NFP, and now we think, if anything, things maybe have swung the other way, not pricing in enough cuts.

Castleton: Does this bring back the dual mandate? We’ve kind of forgotten the inflation side of this and just focused on the employment. Does this bring back inflation, or again are we just overthinking each data point and we need to be more long-term focused here?

Wilensky: I’m concerned that the market’s overthinking this. I believe, at this point, the others, if you will, the other side of the, what was the other side of the dual mandate, the full employment, which has come more into focus in let’s say the last three months, will continue to be the Fed’s main focus. And I think the general picture there is still quite positive, and it would take a pretty big shock on the inflation side to kind of upset that balance, so to speak.

Castleton: Great. So, soft landing, that’s a good overall backdrop. Jeremiah, you focus on U.S. large gap equities, and there’s a thought that rates finally coming down can help U.S. equities broaden outside of just the big winners of the past, and earnings growth will distribute. What’s your view on how the rate cutting cycle and the economy will affect your space?

Jeremiah Buckley: Yeah, so, I’m less focused on the rate cutting cycle. I think it’s appropriate that we’re going through this recalibration and that the direction is lower rates, which I think is appropriate because inflation has come down. I think what’s most important to us on the equity side is the strength of the labor market and that impact on consumer spending. We’re seeing continued positive growth in disposable income, up around 5% in August, and we think that that’s the biggest kind of driver of economic growth. Obviously, we all know how important consumer spending is as part of GDP. And so, what we’re paying attention to is, we want to make sure that we’re not headed towards a cycle of layoffs. And to me, the leading indicator of that historically has been corporate profit margins, which continue to be healthy.

If you look at Q2, corporate profit margins expanded. And so, we continue to have confidence that the layoffs aren’t going to accelerate from here, which leads us to believe that the job market is going to continue to be positive, which supports that consumer spending and supports, you know, what Greg talks about as a soft landing going forward. And so that that’s certainly positive in Q3. We’ve certainly seen some shifts within the market as the Fed, as we got that lower inflation data and the Fed started the rate cutting cycle, you saw a dramatic shift, a rapid shift to interest rate sensitive sectors within the market. In Q3, you had utilities and real estate. That’s the top-performing parts of the market, but also financials and old economy cyclical sectors.

We think that that’s a little premature. That’s assuming that these interest rate cuts will have a dramatic impact on the outlooks for 2025. I think it’s a little early to bank on that. And so, we’re a little skeptical. So, I think it’s really important at this point to be focused on where multiple expansion is warranted versus where it’s not because a lot of those sectors that I mentioned haven’t seen any earnings estimate revisions on the positive side so far this year; it’s been all multiple expansion. And so, the market is assuming that 2025 does accelerate, and I think it’s too early to make that determination. And so we think there are some parts of the market where there’s broadening out has been healthy, but we think there are other parts that are a little bit over ahead of themselves at this point in time.

Castleton: OK. Well, the market has been overzealous on rate cuts for a very long time and wanting them to be a lot heavier and stronger than they had perhaps materialized. So that makes sense, focusing on the job markets. From either of you, are there any other macro factors that we should be focusing on or that you’re focusing on right now as well?

Buckley: Yeah. So related to that, I think labour productivity is the most underrated economic data point that we get. Labour productivity is so important for increasing disposable income. You know, as labor becomes more productive, companies can pay their employees more because they’re producing more. And so that’s the easiest way for us to continue to drive this wealth effect, which drives consumer spending, but it’s also good for corporate margins and making sure that we don’t have this accelerated layoff that I mentioned. And so that focus and the data points over the last three or four quarters have been very positive. We’ve been 2.5% to 3% over those that time period, whereas the long-term average is 1.5%. So that’s very positive. And I would argue that that doesn’t take into account the early benefits of AI. And so, our view is that, over the next number of years, AI should keep us in a higher productivity loop, which should be very good for equity markets and economic growth. And so that’s another area that we’re ultra focused on from a macro standpoint.

Castleton: So, from both of you, is there anything that  you’re focusing on for that multi-asset view?

Buckley: Yeah. So why don’t I start? So, we’re optimistic on both asset classes. I’m sure Greg will talk about fixed income, but yields are attractive. We think yields are to a point where correlations between equities and fixed income will go back to what we’ve seen historically. So we think that that should be appreciated by investors.

But overall, as I mentioned, given the strong consumer spending outlook and the innovation and productivity that we see going forward, we think the outlook for equities is still positive. We recognize that the market multiple has expanded. It’s a little bit higher than we’ve seen over recent history because of that expectation for faster earnings growth. And so we need to make sure that that plays out. And again, with fixed income providing good yields, we think having exposure to both asset classes is the strategy here.

You know, I’ll let Greg kind of cover what would make us change that view…

Wilensky: Well, before I jump in, I just want to echo something that Jeremiah said at the first part of his answer. And that is we’re now at this spot where not only have income in fixed income, but given the starting level of yields and that outlook for the economy and where maybe the risks skew if we’re wrong, we’re feeling very comfortable in this idea that if the economy were to have a not soft landing, so to speak, that fixed income is in a good position to act as that buffer or hedge in a multi-asset strategy. So that makes us more optimistic in general about when we’re bringing these asset classes together.

Certainly as we’re looking at, if you’re talking about what could change the view, kind of almost any of the inputs that you’ve heard us talk about here. If we were to start to see a significant weakening in the economy, and what does that mean from a flow-through perspective into consumer spending and earnings and profitability, that could cause us to move into a more conservative posture from an asset allocation perspective. So we’ll be looking out for that, always looking at valuations on both sides of the ledger. And we always think of, you know, trying to think of from a competition of capital perspective, which asset class is more attractive.

Other things that certainly we can look at on the landscape and we’re constantly monitoring, but we try not to kind of overly factor it into our decision on a predictive basis, if you will, is what’s going on from a geopolitical perspective. I think the best way to deal with that is tends to be a little more reaction. Look what happens and then look at how the market reacts if something were to, if tensions were to increase, something in the Middle East or in China, things like this. We examine what’s happened, we examine how the markets react. And if we determine that we’re supposed to get more conservatively positioned, we’ll tilt the weight away from equities towards fixed income. But really difficult to predict some of those things in advance.

Castleton: Well, that’s great. Thank you for that. And what I’ve been hearing is useful for our listeners. I think there’s way too many headlines on the 60/40 portfolio being dead. And very clearly, it seems like the 40 of fixed income has now come back to be that ballast of equities, and the ability to be flexible if things do change is really why you own a diversified portfolio. So that’s really helpful.

I want to narrow in on maybe more narrow fundamental opportunities within both of your asset classes. Greg, maybe I’ll actually just start with you within fixed income, because we did talk about yields are at a level that they haven’t been for a very long time. How do you view the relative landscape within fixed income and in credit in specifically?

Wilensky: So, let’s start out on, when we look at what’s going on in credit, and we consider credit to be both corporate credit and securitize credit as well. If you look at corporate credit spreads there, if you look just in a backward-looking lens, they look tight versus their historical averages. But you know what, we look and think there’s a lot of reason, good reasons to justify that, frankly. From a fundamental perspective, the general macroeconomic outlook is pretty positive. Companies are being pretty reasonable in kind of the type of leverage and risks they’re taking on within their balance sheet. So that helped the combination of macro backdrop, and company behavior justifies spreads being tighter than average.

And then the market technicals are pretty darn attractive overall. Whether we talk about this from the amount of demand that we’re seeing for fixed income assets, money is flowing into fixed income for sure over the last year. And that doesn’t even account for the fact that there’s still, $7 trillion sitting on the sidelines in money market funds. So we’re seeing strong demand for fixed income assets that we think will is likely to continue, and that is likely to be supportive of keeping spreads at kind of below-average type levels.

When we look across sectors or subsectors within fixed income, corporate spreads look a bit tighter. Securitized spreads, we’re talking about things like CMBS or ABS or non-agency residential mortgage-backed securities. The spreads there actually look relatively more attractive than what we’re seeing on the corporate side. So from a relative value perspective, we’d prefer to be tilted in that direction. We think those sectors, if you will, are pricing in, are better protecting you, if our soft-landing scenario doesn’t play out. I.

Castleton: I think that’s great to say, so as investors are looking to put cash to work in fixed income, it is important to look at the spread level that you’re getting, and which one will be pricing in that more downside buffer if things go sideways. Because it is impossible to predict what’s going to happen. So, thank you for laying that out. The other question, they say, is also just about duration. So, how have you viewed duration? Are we too late? Is it still attractive? How do you view that in general, and other areas that you’re liking in fixed income?

Wilensky: For duration, it is important to still be nimble, because in just thinking about it in the last year, we’ve gone through several cycles where at first, thinking back to last year, we thought the market was pricing in too many hikes, then it was pricing in too many cuts, as in the very end of last year. And then we’ve seen two waves already occur this year.

We were starting to feel as we were coming up on the Fed cut, and the Fed cut in September, and where the market was pricing afterwards that the market was getting pretty aggressive in pricing in the future path of Fed cuts. So we were kind of thinking that duration was getting relatively unattractive. Fast forward, you know, a week, if you don’t like what you see it may change. Now, post the nonfarm payroll number and the sharp rate backup we’ve seen there, I think that calculus has changed, and we are looking to like duration on a standalone basis a little more. And especially when we think in the context of multi-asset portfolios, it again accentuates the ability for fixed income to act as that hedge if the economy softens more than we expect. So it is something that we can look at and say we may want to lean into more now.

Castleton: That’s great. Thank you. So, one more for you and then we’ll go to the equity side. Wha’s your outlook on the new issuance of U.S. corporate bonds? You mentioned corporate, it’s a good backdrop there. But what opportunities do you see in relation to this?

Wilensky: So corporate issuance and credit product issuance in general has been very robust this year. Over $1.2 trillion in investment grade corporate bonds have been issued year to date. I think if we look at the full-year forecast, we’ll probably hit a record, except for the 2020 year itself. So, seeing a lot of issuance there. I think this has actually been positive in many respects. First, we’ve seen that high issuance met with even higher demand and that goes back to the technicals. Part of this is money flowing in, part of this is the fact that yield levels are high. So even though spread levels are above normal, yield levels are at the highest level we’ve seen since the GFC [Global Financial Crisis], and that’s causing money to come into the sector. So that’s encouraging to see there.

The other thing that I think makes us encouraging was people were starting to talk about the wall of maturities coming up in ‘25 and ‘26 and the fact that the new issue market, whether in investment grade or in high yield or in securitized, is pretty much wide open. People can issue, maybe with the exception of very distressed corporations, and this actually has a nice positive fundamental feedback loop in that companies are able to refinance upcoming maturities, and that puts them into a more stable position going forward. We would expect I think some of the issuance that we’ve seen year to date or some of that extra issuance, I think there is a bit of a pull-forward going on because of upcoming elections and the idea that people want to get their issuance done early in case there is volatility or uncertainty going forward. So I think that pace of issuance will tamp down a little bit as we get into the last couple months of the year, but I still think it’s going to be more normal rather than above normal.

Castleton: OK, great. Well, thank you for that outlook. Let’s transition to you, Jeremiah. Talk about equities a little bit more. One of the things you focused on in the beginning is just labor productivity being so important. So are there any recent trends or developments that you’ve seen in productivity or innovation? And I think we’re going to have to bring up AI in that question.

Buckley: So, I think the strong productivity that we’re seeing today is a result of the technology spending and the R&D spending that we’ve done over the last few years. And you know, the pandemic accelerated this transition and that technology spending and move to the cloud. We think that generative AI is going to be a transformation that takes it to the next level. We think that revenue per employee is going to accelerate from here. And if we look at long term charts of the, you know, the S&P 500 and revenue per employee, when we’ve seen those technological transformations, we’ve seen a step up in productivity.

And so the early anecdotes, and again it’s early with the adoption of generative AI, a lot of enterprises are kind of dipping their toe in the water and experimenting. But the early results are really impressive. You know, I used to be an industrial analyst and we would be excited when a company would show 6% productivity because they were using 6 Sigma. Now we’re talking multiples of productivity for labor. And so we think that this opportunity to both accelerate revenue growth because it’s enabling more products to be developed, more products to be distributed, and optimizing going to market with consumers, it’s also going to result in a lot of labor productivity and efficiencies that we think can help margins over time. So we we think this technology is really, again, transformational. We think investing in the infrastructure piece of that, so not only is it semiconductors and cloud service providers, but it’s also, you know, utilities are likely to see increased electricity demand. Industrial companies that supply either the cooling or some of the electrical components that enable this will continue to benefit from this. I know a lot of those have already driven a lot of the market gains, but we think the growth outlook continues to be quite positive. Over time, we’re going to need companies to see more of that benefit.

I mentioned that it’s early and that they’re experimenting. We need those companies to realize those benefits and get a return on all of this AI spending. And so that will be critical. We think that that will first come for the largest companies. I’m biased, but I believe U.S. large caps are really well positioned over the next few years because of this need for scale and the amount of data that’s required to effectively improve your strategy and your efficiency with AI. And so the companies that are early adopters that have those R&D and tech budgets to realize the benefits of this transformation, we think will be the first to benefit. And so, we think it will broaden out not just from the infrastructure players, but for those companies that adopt this technology rapidly. We think that those will be beneficiaries as well.

Castleton: That was a question I was going to ask. There is a lot of debate on all the spend that’s going on and how is it going to reach to the bottom line. It sounds like you’re optimistic, but you’re playing it in a cautious way at the moment.

Buckley: So, we’ve seen a significant acceleration in capital spending. All the signs today indicate that we’re likely to get a return on that. But certainly, it’s important to continue to watch that and make sure that we’re not over-investing and we go into a period where we have to rationalize that investment. And I don’t think that would be positive for the overall economy. That would be one reason I think we would have to think about adjusting the attractiveness between equities and fixed income, is if we’re not getting return on that capital because it is driving a lot of economic growth. But we need to make sure that that realizes the returns over time. But so far, you know, the hyperscalers are seeing the benefits. Demand for servers and semiconductors continues to be quite positive.

Castleton: Right. Well, the world is not just AI, so what are some of the other maybe attractive opportunities that you’re seeing?

Buckley: So I think one area that we continue to think there are a lot of opportunities in this healthcare. We’ve seen tremendous scientific breakthroughs in a number of disease areas over the last number of years, whether it be oncology, immunology, diabetes and now obesity certainly being top of the headlines. And so we think that that R&D will continue to drive attractive growth.

The other aspect of healthcare that we like is that we think the sector is both defensive as well as offensive. So the offensive piece is this continued improvement in R&D and the innovation that comes from that. But obviously if we were to go into an economic slowdown that was worse than expected, you know, pharmaceuticals and biotech obviously provide more ballast as volumes are unlikely to materially decline in in an economic slowdown. And so we like that aspect of the industry.

I think there are a couple areas of the market as well that they’re excited about within financial services. You know, as interest rates come down, we think capital markets are likely to be better than they have been the last couple years. We had all this pull forward during the pandemic, and then we had this lull as people had their financing and there wasn’t a lot of activity. And now with the debt issuance this year being so strong, we think equity issuance has to improve from where it’s been. And so we think that that’s an opportunity, and given all the volatility that we’re seeing in the market, that’s also good for a lot of financial services companies that provide those services, whether it be trading or futuristic exchange, those types of business models.

And then the last piece is, you know, we talked early on about consumer spending. Certainly, the consumer has had to make choices with higher inflation over the last couple of years, but there’s still … consumer balance sheets are still really healthy. They’ve seen their home prices appreciate, they’ve seen their investment portfolios appreciate, they’re getting pretty good interest income on their money market funds today. And so we think that that will continue to drive discretionary spending. And so, you know, areas like travel or experiences continues to be a strong area of growth that we continue to be excited about.

Castleton: What about you, Greg?

Wilensky: Well some of them overlap actually with the concepts that Jeremiah was talking about, when we’re talking about AI. Well, this is creating tremendous demand for data centers, and we’re seeing a lot of data centers now being financed within the securitized market, CMBS or ABS, where these deals are backed essentially by leases, long-term leases to some of the big hyperscalers who are have high credit ratings. But that generally means in the corporate area, they have very tight spreads. So we think there’s opportunities for investors to pick up a significant amount of spread while maintaining high credit quality and keeping their portfolios kind of biased towards conservative investments.

Other areas such as the housing market, as we’ve seen a slowdown in turnover in the housing market because of high mortgage rates, there’s been increased issuance in sectors like second-lien mortgages that are being used to finance renovations or mortgages that are being made to builders who are redeveloping projects or houses. And these are, again, generally very high-quality assets that offer a nice spread pickup relative to corporate bonds. So that’s an area that investors can look at to keep high quality and yield in their portfolios.

And then finally, another one of the topics that Jeremiah mentioned when we will think about the banking and financial sectors, a lower policy rates means lower deposit rates. This means higher net interest margins for banks, so this can provide a tailwind for those for banking issuers. Although I think investors do need to be aware that spreads in the banking sectors relative to industrial corporates have compressed over the last year. So some of that is being priced in.

Castleton: Great. This was awesome. You guys walked through a lot of really good fundamental examples, outlook for the economy. Any final words to listeners and investors, just on the benefit of owning a balanced strategy, or anything that you see that they should be aware of to leave with?

Buckley: my comment or advice would be to stay invested. As investors, often we fail to recognize the opportunity cost of staying in cash. You can get higher yields in fixed income most of the time, you can get higher long-term returns in equities, and a lot of times when there’s volatility in the market, investors get scared out of higher-risk assets. And during that volatility, if you miss the recovery, it often feels worse to invest in the middle of that, you miss a lot of the returns that you realize over time in riskier assets. And so I think it’s important, you should choose your appropriate risk profile, but stay invested and appreciate the opportunity cost of being invested in cash.

Castleton: Great ending points. I saw some research recently, actually. Historically, investors have tended to not really significantly sell out of money markets until that 2% threshold, which is very far from where we’re at today. And you laid out both the fixed income and equity options for people to turn to today, especially if you can focus on those fundamentals, with labor productivity, earnings growth, and where your spreads are within fixed income. So, appreciate you walking us through the entire state of fixed income, equity, and multi-asset landscape, and we hope you found the conversation useful.

For more insights from Janus Henderson, you can download other episodes of Global Perspectives wherever you get your podcasts, or visit janushenderson.com. I’ve been your host for the day, Lara Castleton. Thanks. See you next time.

Basis point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.

Credit Spread is the difference in yield between securities with similar maturity but different credit quality. Widening spreads generally indicate deteriorating creditworthiness of corporate borrowers, and narrowing indicate improving.

Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.

Nonfarm payroll, also known as non-farms or NFP, is a monthly count of the number of jobs in the US private sector and government agencies released by the US Bureau of Labor Statistics monthly. It excludes people who work in agriculture, private households, non-profits, or the military.

S&P 500^® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.